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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the transition period from __________ to __________.

Commission file number 001-16757

DJ ORTHOPEDICS, INC.

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

Indicated by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

The aggregate market value of all outstanding common equity held by non-affiliates of the Registrant based on the closing price of common stock as reported on the New York Stock Exchange on June 28, 2002, was $75,490,585.

The number of shares of the Registrant’s common stock outstanding at February 28, 2003 was 17,901,796 shares.

Documents Incorporated by Reference

Portions of the Proxy Statement for the Registrant’s 2003 Annual Meeting of Stockholders to be filed with the Commission on or before April 30, 2003 are incorporated by reference in Part III of this Annual Report on Form 10-K. With the exception of those portions that are specifically incorporated by reference in this Annual Report on Form 10-K, such Proxy Statement shall not be deemed filed as part of this Report or incorporated by reference herein.

Table of Contents

DJ ORTHOPEDICS, INC.

FORM 10-K
TABLE OF CONTENTS

Explanatory Note

     This annual report on a Form 10-K is filed for dj Orthopedics, Inc. (dj Orthopedics), a Delaware corporation. It is also filed for dj Orthopedics, LLC (dj Ortho), a Delaware limited liability company and DJ Orthopedics Capital Corporation (DJ Capital), a Delaware corporation, with respect to the 12 5/8% Senior Subordinated Notes (the Notes) due in 2009 in an original aggregate principal amount at maturity of $100 million that were co-issued by dj Ortho and dj Capital. dj Orthopedics owns 100% of the equity interest of dj Ortho and does not otherwise own any material assets or business operations. The financial position and operating results of dj Orthopedics and dj Ortho are, therefore, substantially the same and are reflected in the consolidated financial information contained in this report. dj Capital was formed solely to act as co-issuer of the Notes and does not hold any assets or conduct any business operations of its own. Financial information for dj Capital would not be meaningful and is not included in this annual report.

Note on Forward-Looking Information

     This annual report on Form 10-K includes forward-looking statements intended to be within the safe-harbor for such statements provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements reflect our current estimates, expectations and projections about our future results, performance, prospects and opportunities. Forward-looking statements include, among other things, the information concerning our possible future results of operations, business and growth strategies, financing plans, cost reduction programs, our competitive position and the effects of competition and the projected growth of the markets in which we operate. Forward-looking statements include all statements that are not historical facts. In some cases, you can identify these statements by forward-looking words such as anticipate, believe, could, estimate, expect, intend, may, should, will, plan, intend, would and similar expressions. These forward-looking statements are based on information currently available to us and are subject to a number of risks, uncertainties and other factors that could cause our actual results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, the forward-looking statements we make in this annual report. Important factors that could cause our actual results to differ materially from the results referred to in the forward-looking statements we make in this annual report are discussed under “Risk Factors” and elsewhere in this annual report, and you are cautioned to consider these risk factors in connection with such forward-looking statements.

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Part I

Item 1. Business

Overview

     We are a global orthopedic sports medicine company specializing in the design, manufacture and marketing of products that rehabilitate soft tissue and bone injuries, help protect against injury, and treat osteoarthritis of the knee. Osteoarthritis is a form of damage to or degeneration of the articular surface of a joint. Our broad range of over 600 existing products, many of which are based on proprietary technologies, include rigid knee braces, soft goods and specialty and other complementary orthopedic products which provide solutions for patients and orthopedic sports medicine professionals throughout the patient’s continuum of care. Our products can be grouped into three broad categories as follows:

	•		Rigid Knee Braces. Our DonJoy® line of rigid knee braces includes ligament braces, which provide support for knee ligament instabilities, post-operative braces, which provide both knee immobilization and a protected range of motion, and osteoarthritic braces, which provide relief of knee pain due to osteoarthritis. These technologically advanced products are generally prescribed by orthopedic sports medicine surgeons. Our rigid knee braces are either customized braces, utilizing basic frames which are then custom-manufactured to fit a patient’s particular measurements, or are standard braces which are available “off-the-shelf” in various sizes and can be easily adjusted to fit the patient in the orthopedic professional’s office.
	•		Soft Goods. Our soft goods products, most of which are constructed from fabric or neoprene materials, provide support and/or heat retention and compression of the knee, ankle, back and upper extremities, including the shoulder, elbow, neck and wrist.
	•		Specialty and Other Complementary Orthopedic Products. Our portfolio of specialty and other complementary orthopedic products includes two post-surgery systems: a continuous cold therapy system to assist in the reduction of pain and swelling; and a pain management delivery system that employs ambulatory infusion pumps for the delivery of local anesthetic to the surgical site. Also included within this product category are lower extremity fracture boots, which are an alternative to lower extremity casting, and upper extremity shoulder and arm braces and slings.

     In this annual report, the terms we, our, and us refer to dj Orthopedics, Inc., a Delaware corporation, and its subsidiaries. The principal operating subsidiary of dj Orthopedics, Inc. is dj Orthopedics, LLC, a limited liability company organized in Delaware. We are the successor to DonJoy, L.L.C., and that company was, prior to June 30, 1999, a wholly owned subsidiary of Smith & Nephew, Inc. Our executive offices are located at 2985 Scott Street, Vista, California 92083, and our telephone number is (800) 336-5690. Our website is www.djortho.com.

     We file annual reports, such as this Form 10-K, as well as quarterly reports on Form 10-Q and current reports on Form 8-K, with the U.S. Securities and Exchange Commission (SEC). We make these reports available free of charge on our website under the investor relations page. The reports can be accessed the same day as they are filed with the SEC. All such reports were made available in this fashion during 2002.

Performance Improvement Program

     In August 2002, we commenced a company-wide performance improvement program with the objective of increasing revenues and reducing both costs of goods sold and operating expenses as a percentage of net revenues beginning in 2003. We retained the services of AlixPartners, LLC, a consulting firm specializing in corporate performance enhancement, to assist with the performance improvement program.

     With the goal of reducing costs by streamlining our organization structure, we began our performance improvement program with the elimination of several senior management positions. In September 2002, we also commenced the move of the manufacturing of all our remaining soft goods and certain non-custom rigid braces manufactured in the United States to our manufacturing facilities in Mexico. The move of these manufacturing operations was completed by the end of 2002 and resulted in the elimination of approximately 200 U.S. positions. A comparable number of positions were added in Mexico. The manufacturing move is expected to result in reduced manufacturing costs. Other focuses of the performance improvement program include reducing operating expenses; improving the profitability of revenue from our OfficeCare® channel; reducing working capital and improving our business processes and information systems. Although the performance improvement program was substantially completed by the end of 2002, no assurance can be given that it will be successful in achieving the desired goals.

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Business Segments

     In connection with the performance improvement program, we refocused our resources on our core business within the rehabilitation segment of the orthopedic sports medicine market. We have discontinued our surgical line of products sold under the Alaron® brand and will not enter the total joint replacement market at this time. We have organized our business around our distribution channels and are presenting our financial information in this annual report according to business segments corresponding to these channels. The channels are:

	•		DonJoy® sales, in which our products are sold through independent sales agents and their direct and indirect sales representatives to orthopedic surgeons, orthotic and prosthetic centers, hospitals and other sports medicine outlets;
	•		ProCare® , in which products are sold primarily to national third party distributors, regional medical supply dealers and medical product buying groups;
	•		OfficeCare®, in which we maintain an inventory of product on hand at orthopedic practices for immediate disbursement to the patient and we arrange billing to the patient or third party payer; and
	•		International, in which our products are sold in foreign countries through wholly owned subsidiaries or independent distributors.

Strategy

     Our strategic objectives are to strengthen our leadership position in the orthopedic sports medicine market and to increase our revenues and achieve profitability. The key elements of our business strategy include:

     Focus on our Core Business. An important part of our performance improvement program is a commitment to focus on our core rehabilitation business. While we may in the future move into the repair and regeneration segments of the orthopedic sports medicine market, our emphasis at this time is in rehabilitation and will include increased attention to and resources in developing and marketing new and innovative rehabilitation products, as well as increasing market share for our existing products. To this end, we have ceased active commercialization of our Alaron® surgical product line and have discontinued marketing our knee replacement product. In 2001, we entered into an agreement with I.M.D., b.v. (IMD) to distribute a bone growth stimulator, OrthoPulse™, which was planned to be our first product in the regeneration market. We intend to follow closely the efforts of IMD to obtain approval of the U.S. Food and Drug Administration for its OrthoPulse product (see Products – Specialty and Other Complementary Orthopedic Products – Bone Growth Stimulator).

     Applying our Engineering and Manufacturing Expertise to Introduce New Products and Product Enhancements. We intend to remain an innovator of orthopedic sports medicine products through our commitment to research and development and our close working relationships with orthopedic professionals by designing, developing and introducing products in the orthopedic sports medicine market. Using our materials, process and design expertise in bracing and supports, we will continue to enhance our current range of products to address changing customer needs, emphasizing high quality product designs that will reduce labor and material costs. In addition, we intend to add complementary products through our own research and development efforts and arrangements with third parties. For example, we have introduced two pain management systems, the IceMan® device, a cold therapy system, which we developed, and the PainBuster® Pain Management System, a range of ambulatory infusion pumps. In early 2003, we released the Fource Point ™ knee brace, our latest advancement in rigid knee braces for ligament protection and rehabilitation, and a new fracture boot product for patients with diabetes-related foot problems.

     Enhance Effectiveness and Profitability of our OfficeCare® Channel. We plan to increase the profitability and decrease the required amount of working capital in our OfficeCare channel through the successful implementation of our contract to outsource the revenue cycle aspects of the business to a third party. Our outsource partner will be responsible for order entry, billing and collections, permitting us to concentrate on manufacturing, building relationships with orthopedic practices, inventory controls, and customer service. We believe that this distribution channel serves a growing need among orthopedic practices and represents an opportunity for significant growth for our entire line of products.

     Securing Additional National Accounts. We plan to capitalize on the growing practice in healthcare in which hospitals and other large healthcare providers seek to reduce costs by outsourcing their purchasing activities to national buying groups. (See Distribution Channels – ProCare®.) Contracts with these national accounts represent a significant opportunity for sales in large volumes. We believe that our broad range of products is well-suited for the goals of these buying groups and intend to pursue these contracts aggressively.

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     Growing International Revenues and Profits through Direct Representation in Key Countries. We intend to increase our international revenues and profits in key countries where we believe the opportunity for growth is significant due to high per capita healthcare spending. We believe that direct control of the distribution networks in selected countries through wholly-owned subsidiaries will allow us to accelerate the launch of new products and product enhancements, to benefit from the sale of our higher margin, value added products and to capture the distributor’s margin. We have established subsidiaries in Germany and the United Kingdom effective January 1, 2002 and in Canada effective May 7, 2002. We market products in over 40 countries, primarily countries in Europe, as well as in Australia, Canada and Japan. International sales accounted for approximately 13% and 11% of our net revenues, excluding freight revenue, in 2002 and 2001, respectively.

     Increasing Margins by Capitalizing on Operating Efficiencies Achieved in our Performance Improvement Program. We plan to capitalize on the improved operating efficiencies generated in our performance improvement programs to enhance gross margins and reduce operating expenses. We have moved the bulk of our labor-intensive operations to our facilities in Mexico to generate labor cost savings. We have converted our manufacturing scheduling to produce finished goods on customer demand and are in the process of converting our procurement process to enable us to replenish our supply of raw materials upon usage. Both processes will allow us to decrease the level of inventory necessary to operate the business as well as reduce the risk of excess and obsolete inventory. We also plan to achieve cost savings by further reducing the number of stock keeping units (SKUs) without impacting service or breadth of our product range. Additionally, we have streamlined our organization and improved our cost structure by consolidating certain executive positions and corporate functions.

     Pursuing Strategic Growth Opportunities by Acquiring or Licensing Complementary Products and Technologies. We may continue to acquire or license complementary products and technologies applicable to the orthopedic sports medicine market that will allow us to broaden our product lines and leverage our existing infrastructure, distribution networks, brand name recognition and expertise in research and development.

Products

     Rigid Knee Bracing

     We design, manufacture and market a broad range of rigid knee bracing products, including ligament braces, post-operative braces and osteoarthritic braces. These technologically advanced products are generally prescribed to a patient by an orthopedic sports medicine surgeon. Our rigid knee braces are either customized to fit a patient’s particular measurements or are standard braces which are available “off-the-shelf” in various sizes and can be easily adjusted to fit the patient in the orthopedic professional’s office.

     Ligament Braces. Ligament braces provide durable support for moderate to severe knee ligament instabilities to help patients regain range of motion capability so they can successfully complete rehabilitation and resume the activities of daily living after knee surgery or injury. Ligament braces are generally prescribed six to eight weeks after knee surgery, often after use of a more restrictive post-operative brace. Our ligament braces can also be used to support the normal functioning of the knee. Our ligament bracing product line includes premium customized braces generally designed for strenuous athletic activity and off-the-shelf braces generally designed for use in less rigorous activity. All of our ligament braces are designed using our patented “Four Points of Leverage” system. This system exerts a force on the upper portion of the tibia, which, in turn, reduces strain on the damaged, reconstructed or torn ligament. Our U.S. patent covering the “Four Points of Leverage” system expires in January 2005.

     Post-operative Braces. Post-operative braces limit a patient’s range of motion after knee surgery and protect the repaired ligaments/joints from stress and strain which would slow or prevent a healthy healing process. The products within this line provide both immobilization and a protected range of motion, depending on the rehabilitation protocol prescribed by the orthopedic sports medicine surgeon. Our post-operative bracing product line includes a range of premium to lower priced off-the-shelf braces and accessory products. We also offer the patented DonJoy Vista™ Rehabilitation System that facilitates patient rehabilitation in a home or clinical setting by motivating and improving compliance of patients through continuous feedback and recorded home exercise sessions.

     Osteoarthritic Braces. Osteoarthritic braces are used to treat patients suffering from osteoarthritis. Our line of customized and off-the-shelf osteoarthritic braces is designed to shift the load going through the knee, providing additional stability and reducing pain, and in some cases may serve as a cost-efficient alternative to total knee replacement.

     In 2001, we introduced the Knee Guarantee™ program, in relation to our Defiance® knee brace. The Knee Guarantee program will, in specified instances, cover a patient’s insurance deductible up to $1,000, or give uninsured patients $1,000, towards surgery should an ACL re-injury occur while wearing the brace. As of December 31, 2002, claims under this program were minimal.

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     The following table sets forth information on our primary products within the three rigid knee bracing product lines, all of which are sold under the DonJoy® brand name.

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     Soft Goods

     Our soft goods products, most of which are fabric or neoprene-based, provide support and/or heat retention and compression for afflictions of the knee, ankle, back and upper extremities, including the shoulder, elbow, neck and wrist. We currently offer products ranging from simple neoprene knee sleeves to complex products that incorporate advanced materials and features such as air-inflated cushions and metal alloy hinge components.

The following table sets forth information on our primary soft goods products:

     Specialty and Other Complementary Orthopedic Products

     We have a portfolio of specialty and other complementary orthopedic products designed to facilitate orthopedic rehabilitation, including cold therapy systems, pain management systems, lower extremity fracture boots, upper extremity braces, and other related products and accessories.

     Cold Therapy Systems. We manufacture, market and sell the IceMan® device, a cold therapy product, which was introduced in 1996, as well as other cold therapy products such as ice packs and wraps. The IceMan product is a

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portable device used after surgery or injury to reduce swelling, minimize the need for post-operative pain medications and accelerate the rehabilitation process. The product consists of a durable quiet pump and control system used to circulate cold water from a reservoir to a pad and designed to fit the injured area, such as the ankle, knee or shoulder. The IceMan® product uses a patented circulation system to provide constant fluid flow rates, thereby minimizing temperature fluctuations which can reduce device effectiveness and create the potential for tissue or nerve damage.

     Pain Management Systems. We are a non-exclusive North American orthopedic distributor of the PainBuster® Pain Management Systems, which are used after surgical procedures. These pain management and relief systems provide a continuous infusion of local anesthetic dispensed by the physician directly into the surgical site following surgical procedures. The portable PainBuster Pain Management Systems consist of a range of introducer needles, catheters for easy insertion and connection during surgery and pumps for continuous infusion for up to 72 hours. The PainBuster Pain Management Systems are intended to provide direct pain relief, reduce hospital stays and allow earlier and greater ambulation. Our distribution rights for these products terminate at the end of 2003, unless extended by mutual consent.

     Lower Extremity Fracture Boots. These products are boots which fit on a patient’s foot and provide comfort and stability for ankle and foot injuries ranging from ankle sprains and soft tissue and stress fractures in the lower leg to stable fractures of the ankle. Fracture boots are used as an alternative to traditional casts.

     In January 2003, Medicare introduced a new reimbursement code relating to tibial ankle-foot fracture boot products. We believe that the new code, which provides for a lower payment value on the applicable devices, may apply to some or all of our lower extremity fracture boot products. We are currently in the process of disputing this change. If we determine that the new code is applicable to all of our lower extremity fracture boots, our revenue from the sale of these products through the OfficeCare® channel could be reduced in the future by up to approximately $5 million annually; however, we expect such reduction will be less than $5 million. Sales of fracture boots represented approximately 51% and 49% of the net revenues, excluding freight revenue, of our OfficeCare® channel for the years ended December 31, 2002 and 2001, respectively.

     Diabetic Lower Extremity Fracture Boots. We recently introduced a line of fracture boots designed for patients suffering from pre-ulcerative and ulcerative foot conditions, primarily related to complications from diabetes. The new fracture boots are a more convenient and hygienic replacement for total contact casting as a treatment for pre-ulcerative and ulcerative conditions of the plantar surface of the foot, most often related to complications from diabetes.

     Upper Extremity Braces. We offer a line of shoulder and arm braces and slings, including the Quadrant® and S.C.O.I. shoulder braces and the UltraSling®. The shoulder braces are technologically advanced and designed for immobilization after shoulder surgery and allow for controlled motion. The UltraSling is a durable oversized sling, which offers lower-priced immobilization and support for mild shoulder sprains and strains.

     Bone Growth Stimulator. In 2001, we entered into an agreement with IMD to distribute a bone growth stimulator (OrthoPulse™) which was planned to be our first product in the regeneration market. We also made an equity investment in IMD. OrthoPulse is currently undergoing the FDA regulatory approval process. On July 1, 2002, notification was received from the FDA that the premarket approval application (PMA) for OrthoPulse was placed on an integrity hold due to concerns that the clinical data that had been submitted in support of the PMA were not reliable. As required by the FDA, an independent review of the clinical data commenced on August 5, 2002. The auditor’s report was submitted on September 30, 2002 and IMD is engaged in an ongoing communications with the FDA to address this matter. Without approval by the FDA, marketing of this product in the United States cannot proceed. In 2001 we purchased a beginning inventory of this product from IMD We cannot distribute such inventory in the United States until FDA approval is obtained, and although we can distribute such inventory in certain other countries which do not require FDA approval, the markets in these countries are smaller than in the U.S. At this point, we do not have an estimate of when or whether final FDA approval will occur, and we have, as a result of this continuing uncertainty, recorded charges to fully reserve our inventories of this product and we have written off our investment in IMD.

Distribution Channels

     We market products in the United States through distinct sales and distribution channels that we categorize as DonJoy®, ProCare®, and OfficeCare®. Sales in the United States accounted for approximately 87%, 89% and 87% of our net revenues, excluding freight revenue, for the years ended December 31, 2002, 2001 and 2000, respectively. Our international channel consists of sales by our foreign subsidiaries and sales through foreign independent distributors.

     DonJoy®. The DonJoy sales channel, which consists primarily of sales of our DonJoy brand rigid knee braces, accounted for approximately 49%, 49% and 52% of our net revenues, excluding freight revenue, for the years ended December 31, 2002, 2001 and 2000, respectively. Products are marketed and sold in this channel by 38 commissioned sales

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agents which employ or contract with over 200 sales representatives who are primarily dedicated to the sale of our products to the orthopedic sports medicine market. These sales representatives market to orthopedic sports medicine surgeons, orthotic and prosthetic centers, hospitals, surgery centers, physical therapists and athletic trainers. Because the DonJoy product lines generally require customer education on the application and use of the product, the sales representatives are technical specialists who receive extensive training both from us and the agent and use their technical expertise to help fit the patient with our product and assist the orthopedic professional in choosing the appropriate product to meet the patient’s needs. After a sales representative receives a product order, we generally ship and bill the product directly to the orthopedic professional and we pay a sales commission to the agent.

     We enjoy long-standing relationships with most of our agents and sales representatives. Under the arrangements with the agents, each agent is granted an exclusive geographic territory for sales of our products and is not permitted to market products, or represent competitors who sell or distribute products, that compete with our existing products. The agents receive a commission which varies based on the type of product being sold. If an agent fails to achieve specified sales quotas, we may terminate the agent, as we have done in the past.

     Our sales agents and representatives also sell rigid knee braces that are custom fit for patients of U.S. orthopedic sports medicine surgeons. We refer to this business program as our “Insurance” program because we sell the brace directly to the patient and take responsibility for insurance billing. We obtain pre-approval from the patients’ insurance company and then seek reimbursement directly from the patients’ insurance company or other third party payor or from the patient when self-pay is applicable. The Insurance program is intended to facilitate the use of our higher cost custom products by orthopedic sports medicine surgeons.

     ProCare®. The ProCare sales channel accounted for approximately 25%, 27% and 25% of our net revenues, excluding freight revenue, for the years ended December 31, 2002, 2001 and 2000, respectively. Products in this channel consist of most of our soft goods line and certain of our specialty and other complementary orthopedic products, which are generally sold in non-exclusive territories under private label brand names to third party distributors. These distributors include large, national third party distributors such as Owens & Minor Inc., McKesson/HBOC, Allegiance Healthcare and PSS World Medical Inc.; regional medical surgical dealers; and medical products buying groups which consist of a number of dealers who make purchases through the buying group. These distributors generally resell the products to large hospital chains, hospital buying groups, primary care networks and orthopedic physicians for use by the patient. Unlike our rigid brace products, these soft goods products generally do not require significant customer education for their use.

     In response to the emergence of managed care and the formation of buying groups, national purchasing contracts and various bidding procedures imposed by hospitals and buying groups, we have entered into national contracts primarily for our soft goods products, but often also covering rigid knee braces, with large healthcare providers and buying groups, such as AmeriNet Inc., US Government/Military hospitals, National Purchasing Alliance, Magnet, Managed Healthcare Association, and Hanger Orthopedic Group. Under these contracts, we provide favorable pricing to the buying group and are generally designated as one of several preferred purchasing sources for the members of the buying group for specified products, although the members are not obligated to purchase our products. We are also the premier supplier for HealthTrust Purchasing Group, Magnet, Managed Healthcare Association and Novation. We expect that in the future we will enter into additional national contracts with other healthcare providers and buying groups. Revenues from group buying organizations accounted for approximately 20%, 20% and 21% of our net revenues, excluding freight revenue, for each of the years ended December 31, 2002, 2001 and 2000.

     OfficeCare®. The OfficeCare sales channel accounted for approximately 13%, 13% and 10% of our net revenues, excluding freight revenue, for the years ended December 31, 2002, 2001 and 2000, respectively. In 1996, in response to the needs of certain customers, we launched the OfficeCare program, an inventory management and insurance billing program for certain U.S. orthopedic sports medicine surgeons. Under the OfficeCare program, we provide the orthopedic sports medicine surgeon with an inventory of our orthopedic products for immediate disbursement to the patient. We then seek reimbursement directly from the patient’s insurance company or other third party payor or from the patient when self-pay is applicable. The OfficeCare program is intended to facilitate the introduction of our products to orthopedic sports medicine surgeons who had not previously been our customers. We have outsourced the revenue cycle portion of this program, from order entry to billing and collecting, to an independent third party contractor, allowing us to concentrate on the aspects of this channel that are core to our business. As of December 31, 2002, the OfficeCare program was located at over 500 physician offices throughout the United States.

     As a result of the growth of this program, our working capital needs have significantly increased due to higher levels of accounts receivable and inventories necessary to operate the program. In addition, this program has increased our involvement in the third party reimbursement process, or in certain cases, our direct billings to the patient. The collection period for these receivables as compared to other portions of our business is significantly longer and has also resulted in a need to increase our accounts receivable provision for contractual allowances and doubtful accounts. As noted in our

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critical accounting policies and estimates, we increased our related reserves by an aggregate of $6.7 million for the year ended December 31, 2002.

     International. We market our products in over 40 countries, primarily countries in Europe as well as in Australia, Canada and Japan. Excluding freight revenue, the International sales channel accounted for approximately 13%, 11% and 13% of our net revenues for the years ended December 31, 2002, 2001 and 2000, respectively.

     International sales are currently made through two distinct channels: independent third party distributors, including Smith & Nephew sales organizations in certain countries, and through wholly owned foreign subsidiaries in Germany and the United Kingdom (in each case since January 1, 2002) and in Canada (since May 2002). We had formed a majority owned distribution subsidiary in Australia in 2001, and that company was focusing on surgical products including a knee replacement product. In late 2002 we decided to discontinue commercial activities on that product, as well as most of our other surgical products, and in light of that decision, the establishment of a subsidiary in Australia was no longer attractive. At the end of 2002, we sold our inventory of the knee replacement product back to the manufacturer and sold our interest in the Australian subsidiary to the minority shareholder. The former Australian subsidiary will continue to sell our products as an independent distributor.

Research and Development

     Our internal research and development program is aimed at developing and enhancing products, processes and technologies in order to remain an innovator in the orthopedic sports medicine market. Our research and development expenditures were $2.9 million, $2.3 million and $2.9 million in 2002, 2001 and 2000, respectively.

     Our research and development activities are conducted in our Vista facility by a group of product engineers and designers who have substantial experience in developing and designing products using advanced technologies, processes and materials. The research and development team uses computational tools and computer aided design (CAD) systems during the development process which allow a design to be directly produced on computer-based fabrication equipment, reducing both production time and costs. Our current research and development activities are focused on using new materials, innovative designs and state of the art manufacturing processes to develop new products and to enhance our existing products. We are also pursuing strategic initiatives to identify areas for technological innovation and to develop products that improve patient rehabilitation by utilizing advanced technologies.

     We have developed and maintain close relationships with a number of widely recognized orthopedic sports medicine surgeons and sports medicine specialists who assist in product research, development and marketing. These professionals often become product champions, speaking about our products at medical seminars, assisting in the training of other professionals in the use and fitting of the products and providing us with feedback on the industry’s acceptance of the new products. Some of these surgeons and specialists who participate in the design of products or provide consulting services have contractual relationships with us under which they receive royalty payments or consultant fees in connection with the development of particular products with which they have been involved. Our medical advisory board, consisting of four orthopedic sports medicine surgeons and one certified orthotist, also assists in our product development by advising us on technological advances in sports medicine, along with competitive and reimbursement updates within the orthopedic sports medicine industry.

     We maintain a clinical education research laboratory in our Vista facility, which is used by orthopedic sports medicine surgeons to evaluate our soft tissue repair products in a simulated surgical setting and practice surgical technique. These surgeons often provide us with feedback, which assists us in the development and enhancement of products. In addition, we utilize our biomechanical laboratory in the Vista facility to test the effectiveness of our products. U.S. based and international surgeons and researchers collaborate with our research staff to perform biomechanical testing. The tests are designed to demonstrate the functionality of new products and the effectiveness of new surgical procedures. State of the art mechanical models are used to simulate behavior of normal, injured and osteoarthritic knees and observe the performance of new product designs as well as competitive products. We host numerous orthopedic sports medicine surgeons at our biomechanical laboratory and our surgical technique laboratory, which allows professionals to practice procedures and then to measure the effectiveness of those procedures.

     In addition to our internal research and development efforts, we have entered into a number of technology licensing arrangements with third parties that provide us innovative technologies and processes for the manufacture and development of our products. Finally, we also act as the distributor of a number of products that are manufactured by others.

Manufacturing

     With the substantial completion of our performance improvement program at the end of 2002, most of our products are manufactured in Tijuana, Mexico. The products that are still manufactured in Vista, California consist of our custom rigid

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bracing products and our cold therapy products. We operate a vertically integrated manufacturing and cleanroom packaging operation and are capable of producing a majority of our subassemblies and components in-house. These include metal stamped parts, injection molding components and fabric-strapping materials. We also have extensive in-house tool and die fabrication capabilities, which provide savings in the development of typically expensive tools and molds as well as flexibility to respond to and capitalize on market opportunities as they are identified. Utilizing a variety of computational tools and CAD systems during the development process, we can produce a design directly on computer-based fabrication equipment, reducing both tool production time and costs.

     Our Vista, California facility has achieved ISO 9001 certification, EN46001 certification and certification to the European Medical Device Directive and our Mexico facility has achieved ISO 9001 certification. In 2002, our list of certifications for both the Vista and Mexico facilities was expanded to add the new Canadian Medical Device Regulation (ISO 13485). These certifications are internationally recognized quality standards for manufacturing and assist us in marketing our products in certain foreign markets.

     Our manufacturing operations use new and innovative technologies and materials including thermoplastics, various composites and polypropylene glass, as well as a variety of lightweight metals and alloys. We also use Velcro® and neoprene, as well as Drytex®, a wrap-knit nylon and polyester composite, in the manufacture of our products. Most of the raw materials that we use in the manufacture of our products are available from more than one source and are generally readily available on the open market. We source some of our finished products from manufacturers in China as well as other third party manufacturers. In addition, we provide a variety of competitor products through our OfficeCare® program as requested by the surgeon.

Competition

     The orthopedic sports medicine market is highly competitive and fragmented. Our competitors include a few large, diversified orthopedic companies and numerous smaller niche companies. Some of our competitors are part of corporate groups that have significantly greater financial, marketing and other resources than we do. Our primary competitors in the rigid knee brace market include smaller niche companies such as Bledsoe Brace Systems (a division of Medical Technology, Inc.), Breg, Inc., Generation II USA, Inc., Innovation Sports Incorporated and Townsend Industries Inc. In the soft goods products market, our competitors include DeRoyal Industries, Tecnol Orthopedic Products (a division of Encore Medical Corporation) and Zimmer Holdings, Inc. We compete with a variety of manufacturers of specialty and other complementary orthopedic products, depending on the type of product. In addition, in certain foreign countries, we compete with one or more local or regional competitors such as Bauerfeind in Germany and FGP in Italy.

     Competition in the rigid knee brace market is primarily based on product technology, quality and reputation, relationships with customers, service and price. Competition in the soft goods market is less dependent on innovation and technology and is primarily based on product range, service and price. Several competitors have initiated stock and bill programs similar to our OfficeCare program to provide value to their customers. Competition in specialty and other complementary orthopedic products is based on a variety of factors, depending on the type of product. International competition is primarily from foreign manufacturers whose costs are lower due to their ability to manufacture the products within their respective countries.

     We believe that our extensive product lines, advanced product design, strong distribution networks, reputation with leading orthopedic sports medicine surgeons and their allied healthcare professionals and customer service performance provide us with an advantage over our competitors. In particular, we believe that our broad product lines provide us with a competitive advantage over the smaller niche companies which generally have innovative technology in a focused product category, while our established distribution networks and relationship-based selling efforts provide us with a competitive advantage over larger manufacturers.

Intellectual Property

     Our most significant intellectual property rights are our patents and trademarks, including our brand names, and proprietary know-how.

     We own or have licensing rights to over 56 U.S. and foreign patents and over 13 pending patent applications. We anticipate that we will apply for additional patents in the future as we develop new products and product enhancements. Our most significant patent, which is registered only in the United States, involves the bracing technology and design called the “Four Points of Leverage” system. A majority of our ligament bracing products have been designed using the “Four Points of Leverage” system which exerts a force on the upper portion of the tibia, which, in turn, reduces strain on the damaged, reconstructed or torn ligament. Our patent covering the “Four Points of Leverage” system expires in January 2005. Excluding freight revenue, revenues generated from products using our “Four Points of Leverage” system accounted for approximately 22%, 26% and 27% of our net revenues for the years ended December 31, 2002, 2001 and 2000, respectively. Our other significant patents include the Custom Contour Measuring Instrument, which serves as an integral part of the

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measurement process for patients ordering our customized ligament and osteoarthritic braces. In addition, we own patents covering a series of hinges for our post-operative braces, as well as pneumatic pad design and production technologies (which utilize air inflatable cushions that allow the patient to vary the location and degree of support) used in braces such as the Defiance®. We also have patents relating to our osteoarthritic braces and specific mechanisms in a number of our products. In addition to these patents, we rely on non-patented know-how, trade secrets, process and other proprietary information, which we protect through a variety of methods, including confidentiality agreements and proprietary information agreements with vendors, employees, consultants and others who have access to our proprietary information.

     We believe that our patents, trademarks and other proprietary rights are important to the development and conduct of our business and the marketing of our products. As a result, we intend to aggressively protect our intellectual property rights.

Employees

     As of December 31, 2002, we had approximately 1,200 employees. Our workforce is not unionized. We have not experienced any strikes or work stoppages, and management considers its relationships with our employees to be good.

Government Regulation

     Medical Device Regulation

     United States. Our products and operations are subject to regulation by the U.S. Food and Drug Administration (FDA). The FDA regulates the research, testing, manufacturing, safety, labeling, storage, recordkeeping, promotion, distribution, and production of medical devices in the United States to ensure that medical products distributed domestically are safe and effective for their intended uses. In addition, the FDA regulates the export of medical devices manufactured in the United States to international markets.

     Under the Federal Food, Drug, and Cosmetic Act (FFDCA), medical devices are classified into one of three classes—Class I, Class II or Class III—depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness. Our currently marketed products are all Class I or Class II medical devices.

     Class I devices are those for which safety and effectiveness can be assured by adherence to a set of guidelines, which include compliance with the applicable portions of the FDA’s Quality System Regulation (QSR), facility registration and product listing, reporting of adverse medical events, and appropriate, truthful and non-misleading labeling, advertising, and promotional materials (the General Controls).

     Class II devices also are subject to the General Controls and most require premarket demonstration of adherence to certain performance standards or other special controls and clearance by the FDA. Premarket review and clearance by the FDA for these devices may be accomplished through the 510(k) premarket notification procedure. By regulation, the FDA is required to clear a 510(k) premarket notification within 90 days of submission of the application. As a practical matter, clearance often takes longer; however, our products have generally been cleared within the 90-day time period. If the FDA determines that the device, or its intended use, is not “substantially equivalent” to a previously-cleared device or use, the FDA will place the device, or the particular use of the device, into Class III, and the device sponsor must then fulfill more rigorous premarketing requirements.

     A Class III device is a product which has a new intended use or uses advanced technology that is not substantially equivalent to a use or technology with respect to a legally marketed device. The safety and efficacy of Class III devices cannot be assured solely by the General Controls and the other requirements described above. FDA approval of a premarket approval application (PMA) is required before marketing of a Class III product in the United States can proceed. The PMA process is much more demanding than the 510(k) premarket notification process, and normally requires formal clinical studies to demonstrate safety and efficacy.

     In addition, our manufacturing processes are required to comply with the applicable portions of the QSR, which covers the methods and documentation of the design, testing, production, processes, controls, quality assurance, labeling, packaging, and shipping of our products. The QSR also, among other things, requires maintenance of a device master record, device history record, and complaint files. Our domestic facility, records, and manufacturing processes are subject to periodic unscheduled inspections by the FDA. Our Mexican facilities, which export products to the United States, may also be inspected by the FDA. Based on internal audits of our domestic and Mexican facilities, we believe that our facilities are in substantial compliance with the applicable QSR regulations.

     The FDA has broad regulatory and enforcement powers, including the ability to levy fines and civil penalties, to suspend or delay issuance of approvals, to seize or to recall products, and to withdraw approvals.

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     There are only limited restrictions under law on the export from the United States of any medical device that is legally distributed in the United States. However, there are restrictions under U.S. law on the export from the United States of medical devices that cannot be legally distributed in the United States. If a Class I or Class II device does not have 510(k) clearance, and the manufacturer reasonably believes that the device could obtain 510(k) clearance in the U.S., then the device can be exported to a foreign country for commercial marketing without the submission of any type of export request or prior FDA approval, if it satisfies certain limited criteria relating primarily to specifications of the foreign purchaser and compliance with the laws of the country to which it is being exported. All of our products which are exported to foreign countries currently comply with these restrictions.

     International. In many of the foreign countries in which we market our products, we are subject to regulations affecting, among other things, product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. Many of the regulations applicable to our devices and products in such countries are similar to those of the FDA, including those in Germany, our largest foreign market. In many countries, the national health or social security organizations require our products to be qualified before they can be marketed with the benefit of reimbursement eligibility. To date, we have not experienced difficulty in complying with these regulations. Due to the movement towards harmonization of standards in the European Union, we expect a changing regulatory environment in Europe characterized by a shift from a country-by-country regulatory system to a European Union-wide single regulatory system. The timing of this harmonization and its effect on us cannot currently be predicted.

     Federal Privacy And Transaction Law and Regulations

     Other federal legislation requires major changes in the transmission and retention of health information by us. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) mandates, among other things, the adoption of standards for the electronic exchange of health information that may require significant and costly changes to current practices. The U.S. Department of Health and Human Services (HHS) has released three rules to date mandating the use of new standards with respect to certain healthcare transactions and health information. The first rule requires the use of uniform standards for common healthcare transactions, including healthcare claims information, plan eligibility, referral certification and authorization, claims status, plan enrollment and disenrollment, payment and remittance advice, plan premium payments, and coordination of benefits The second rule released by HHS imposes new standards relating to the privacy of individually identifiable health information. These standards not only require our compliance with rules governing the use and disclosure of protected health information, but they also require us to obtain satisfactory assurances that any business associate of ours to whom such information is disclosed will safeguard the information. The third rule released by HHS establishes minimum standards for the security of electronic health information. We will be required to comply with the transaction standards by October 16, 2003, the privacy standards by April 14, 2003, and the security standards by April 21, 2005.

     Third Party Reimbursement

     In recent years, efforts to control Medicare costs have included the heightened scrutiny of reimbursement codes and payment methodologies. Under Medicare, devices are classified by reimbursement codes, which in turn determine each device’s payment levels. Reimbursement codes describing some of our products have from time to time been redefined, which can reduce payment levels or the breadth of products for which reimbursement can be sought under recognized codes. In January 2003, Medicare introduced a new reimbursement code relating to tibial ankle-foot fracture boot products. We believe that the new code, which provides for a lower payment value on the applicable devices, may apply to some or all of our lower extremity fracture boot products (See Products – Specialty and Other Complementary Orthopedic Products above). We are in the process of disputing this change. We also expect that reduction in the total dollar amount available for Medicare payments will occur in the future as the reform process continues for devices. In addition, if federal initiatives such as competitive bidding are enacted or payment adjustments under the Medicare program’s inherent reasonableness authority are implemented, these measures could result in reductions in Medicare payments for our products. Beyond changes in reimbursement codes and payment methodologies, the movement, both domestically and in foreign countries, toward healthcare reform and managed care may continue to result in downward pressure on product pricing. Excluding freight revenue, net revenues from third party reimbursement accounted for approximately 17%, 17% and 13% of our net revenues for the years ended December 31, 2002, 2001 and 2000, respectively. Medicare reimbursement consists of approximately 13% of our net revenues from third party reimbursement, excluding freight revenues, or 2% of our total net revenues, excluding freight revenue, for the year ended December 31, 2002.

     Fraud and Abuse

     We are subject to various federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws. Violations of these laws are punishable by criminal and civil sanctions, including, in some instances, exclusion from participation in federal and state healthcare programs, including Medicare, Medicaid, Veterans Administration health programs and TRICARE. We have never been challenged by a governmental authority

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under any of these laws and believe that our operations are in material compliance with such laws. However, because of the far-reaching nature of these laws, there can be no assurance that we would not be required to alter one or more of our practices to be in compliance with these laws. In addition, there can be no assurance that the occurrence of one or more violations of these laws or regulations would not result in a material adverse effect on our financial condition and results of operations.

     Anti-kickback and Fraud Laws. Our operations are subject to federal and state anti-kickback laws. Certain provisions of the Social Security Act, which are commonly known collectively as the Medicare Fraud and Abuse Statute, prohibit persons from knowingly and willfully soliciting, receiving, offering or providing remuneration directly or indirectly to induce either the referral of an individual, or the furnishing, recommending, or arranging for a good or service, for which payment may be made under a federal healthcare program such as Medicare and Medicaid. The definition of “remuneration” has been broadly interpreted to include anything of value, including such items as gifts, discounts, waiver of payments, and providing anything at less than its fair market value. Many states have adopted prohibitions similar to the Medicare Fraud and Abuse Statute, some of which apply to the referral of patients for healthcare services reimbursed by any source, not only by the Medicare and Medicaid programs.

     Our OfficeCare® program is a stock and bill arrangement through which we make our products and services available in the offices of physicians or other providers. In conjunction with the OfficeCare program, we may pay participating physicians a fee for rental space and support services provided by such physicians to us. In a Special Fraud Alert issued by the Office of Inspector General of the U.S. Department of Health and Human Services (OIG) in February 2000, the OIG indicated that it may scrutinize stock and bill programs involving excessive rental payments or rental space for possible violation of the Medicare Fraud and Abuse Statute, but notes that legitimate arrangements, including fair market value rental arrangements, will not be considered violations of the statute. We believe we have structured the OfficeCare program to comply with the Medicare Fraud and Abuse Statute.

     HIPAA created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing or attempting to execute a scheme or artifice to defraud any healthcare benefit program, including private payers. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation in connection with the delivery of or payment for healthcare benefits, items or services. This statute applies to any health benefit plan, not just Medicare and Medicaid. Additionally, HIPAA granted expanded enforcement authority to HHS and the U.S. Department of Justice (DOJ) and provided enhanced resources to support the activities and responsibilities of the OIG and DOJ by authorizing large increases in funding for investigating fraud and abuse violations relating to healthcare delivery and payment. In addition, HIPAA mandates the adoption of standards for the electronic exchange of health information. See “Business—Government Regulation—Federal Privacy and Transaction Law and Regulations.”

     Physician Self-Referral Laws. We are also subject to federal and state physician self-referral laws. Federal physician self-referral legislation (commonly known as the Stark Law) prohibits, subject to certain exceptions, physician referrals of Medicare and Medicaid patients to an entity providing certain “designated health services” if the physician or an immediate family member has any financial relationship with the entity. The Stark Law also prohibits the entity receiving the referral from billing any good or service furnished pursuant to an unlawful referral, and any person collecting any amounts in connection with an unlawful referral is obligated to refund such amounts. Various states have corollary laws to the Stark Law, including laws that require physicians to disclose any financial interest they may have with a healthcare provider to their patients when referring patients to that provider. Both the scope and exceptions for such laws vary from state to state.

     False Claims Laws. Under separate statutes, submission of claims for payment that are “not provided as claimed” may lead to civil money penalties, criminal fines and imprisonment, and/or exclusion from participation in Medicare, Medicaid and other federally funded state health programs. These false claims statutes include the federal False Claims Act, which prohibits the knowing filing of a false claim or the knowing use of false statements to obtain payment from the federal government. When an entity is determined to have violated the False Claims Act, it must pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. Suits filed under the False Claims Act, known as “qui tam” actions, can be brought by any individual on behalf of the government and such individuals (known as “relators” or, more commonly, as “whistleblowers”) may share in any amounts paid by the entity to the government in fines or settlement. In addition, certain states have enacted laws modeled after the federal False Claims Act. Qui tam actions have increased significantly in recent years causing greater numbers of healthcare companies to have to defend a false claim action, pay fines or be excluded from the Medicare, Medicaid or other federal or state healthcare programs as a result of an investigation arising out of such action.

     Governmental Audits

     Our operations are subject to periodic survey by governmental entities or contractors to assure compliance

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with Medicare and Medicaid standards and requirements. From time to time in the ordinary course of business, we, like other healthcare companies, are audited by or receive claims documentation requests from governmental entities, which may cite certain deficiencies based on our alleged failure to comply with applicable supplier standards or other requirements. We review and assess such audits or reports and attempt to take appropriate corrective action. The failure to effect such action or to obtain, renew or maintain any of the required regulatory approvals, certifications or licenses could adversely affect our business, results of operations or financial condition and could prevent the programs involved from offering products and services to patients.

Risk Factors

     Our ability to achieve our operating and financial goals is subject to risks relating to our business operations, to government regulation, to our debt level and other special risks to our Senior Subordinated Note holders, some of which are noted below.

Risks Related to Our Business

We have just implemented our performance improvement program and may be unable to achieve the future operating efficiencies and results that we desire.

     In the third quarter of 2002, we engaged AlixPartners, LLC, a company specializing in corporate performance improvements, to expedite the development of a financial and operating performance improvement program. An objective of the performance improvement program was to reduce both costs of goods sold and operating expenses as a percentage of our net revenues beginning in 2003. An important component of the program is the outsourcing to a third party contractor of the revenue cycle functions in our OfficeCare® business, and we are relying on improved billing and collection practices as a key element in building a profitable and growing OfficeCare business. While we have implemented this and the other principal factors of the program, there can be no assurance the performance improvement program will be successful or achieve the desired goals.

     As a part of the performance improvement program we moved the majority of our manufacturing operations to our facilities in Mexico. As a part of this move, we increased the employee base in Mexico to approximately 700 employees and added a third facility in Tijuana, Mexico. We have limited experience in managing a Mexican operation of this magnitude, and our ability to manufacture high-quality products in time to meet customer–driven delivery schedules in the new Mexican facilities will be critical to our ability to achieve our operating goals.

     We reported a net loss of $15.2 million in 2002, after charges for impairment of long-lived assets and costs of restructuring and other performance improvement actions, and no assurance can be given that we can reach our profit goals in 2003 and beyond.

If we cannot successfully implement our business strategy, our business, results of operations and potential for growth will be adversely effected.

     Our ability to achieve our business objectives is subject to a variety of factors, many of which are beyond our control. For example, our business strategy contemplates that existing customers for some of our current products will buy new products from us in the future and that we can sell our products to more orthopedic sports medicine professionals than we do now. Similarly, we believe our revenues will increase with the aging of the general population and as individuals engage in increasingly active lifestyles. Our business strategy further contemplates a growth in international sales through the development of direct distribution capabilities in a number of foreign jurisdictions. If our assumptions regarding these trends prove to be incorrect, we may not be successful in implementing our strategy. In addition, the implementation of our strategy may not improve our operating results. We may decide to alter or discontinue aspects of our business strategy and may adopt alternative or additional strategies due to business or competitive factors or factors not currently foreseen, such as the introduction of new products by our competitors and new medical technologies that would make our products obsolete. Any failure to successfully implement our business strategy may adversely affect our business, results of operations and potential for growth.

     If we are not able to develop or license and market new products or product enhancements we will not remain competitive.

     Our future success and the ability to grow our revenues and earnings require the continued development or licensing of new products and the enhancement of our existing products. We may not be able to:

	•		continue to develop successful new products and enhance existing products;
	•		obtain required regulatory clearances and approvals for such products;

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	•		market such products in a commercially viable manner; or
	•		gain market acceptance for such products.

     Our failure to develop or license and market new products and product enhancements could have a material adverse effect on our business, financial condition and results of operations. In addition, if any of our new or enhanced products contain undetected errors or design defects, especially when first introduced, our ability to market these products could be substantially delayed, resulting in lost revenue, potential damage to our reputation and/or delays in obtaining acceptance of the product by orthopedic sports medicine surgeons and other professionals.

     Our competitors may develop new medical procedures, technologies or products that are more effective than ours or that would render our technology or products obsolete or uncompetitive, which could have a material adverse effect on us.

Our transition to direct distribution of our products in selected foreign countries could adversely affect our revenues and income in these countries.

     Our strategy to selectively replace our third party international distributors with wholly owned distributorships might adversely affect our revenue and net income in those countries. Prior to January 2002, we sold products in Germany/Austria, our largest foreign market, and the United Kingdom, which together aggregated $7.2 million of revenue in 2001, or 40% of our 2001 international sales and 4% of total sales, excluding freight revenue, through an independent third party distributor. Commencing January 1, 2002, we began to distribute our products in these countries through wholly owned subsidiaries. Our 2002 net revenues in Germany/Austria and the United Kingdom were $9.1 million, or 41% of 2002 international sales and 5% of total sales, excluding freight revenue. In addition, in May 2002, we began direct distribution in Canada through a wholly owned subsidiary. Although we have no current plan to do so, if we decide to replace our independent distributors in other countries, we may experience temporary disruptions, as we did in Europe, to our business in those countries. Moreover, we have little experience in managing a large international operation, and the creation of direct distribution capabilities in Germany/Austria, the United Kingdom, and Canada has required changes in our organization and the implementation of additional financial and operational controls. We cannot assure you that we will be able to successfully implement these organizational changes and controls.

We rely heavily on our relationships with orthopedic professionals, agents and distributors for marketing our products and our failure to maintain these relationships would adversely effect our business and operating results.

     The sales of our products depend significantly on the prescription or recommendation of such products by orthopedic sports medicine surgeons and other sports medicine professionals. We have developed and maintain close relationships with a number of widely recognized orthopedic sports medicine surgeons and sports medicine specialists who assist in product research, development and marketing. These professionals often become product champions, speaking about our products at medical seminars, assisting in the training of other professionals in the use and fitting of our products and providing us with feedback on the industry’s acceptance of our new products. Failure of our products to retain the support of those surgeons and specialists, or the failure of our products to secure and retain similar support from leading surgeons and specialists, could have a material adverse effect on our business, financial condition and results of operations.

     Our marketing success also depends largely upon marketing arrangements with independent agents and distributors. Our success depends upon our agents’ and distributors’ sales and service expertise and their relationships with the customers in the marketplace. Our failure to maintain relationships with agents and distributors could have a material adverse effect on our business, financial condition and results of operations.

Our international sales may be adversely affected by foreign currency exchange fluctuations and other risks.

     Commencing January 2002, we began selling products through our subsidiaries in Germany and the United Kingdom in Euros and Pounds Sterling, respectively, and, commencing May 2002, we began selling products through our subsidiary in Canada in Canadian Dollars. International sales in 2002 were favorably impacted by foreign currency exchange fluctuations with the weakening of the U.S. dollar against the Euro. In 2001, the volume and product mix of international sales was indirectly adversely impacted by foreign currency exchange fluctuations as the strengthening of the U.S. dollar against the Euro effectively increased the cost of our products to our European third party distributors. As we begin to further directly distribute our products in other selected foreign countries, we expect that future sales of our products in these markets will be denominated in the applicable foreign currencies, which would cause currency fluctuations to more directly impact, our operating results.

     We are also subject to other risks inherent in international operations including political and economic conditions,

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foreign regulatory requirements, exposure to different legal requirements and standards, potential difficulties in protecting intellectual property, import and export restrictions, increased costs of transportation or shipping, difficulties in staffing and managing international operations, labor disputes, difficulties in collecting accounts receivable and longer collection periods and potentially adverse tax consequences. As we continue to expand our international business, our success will be dependent, in part, on our ability to anticipate and effectively manage these and other risks. If we are unable to do so, these and other factors may have a material adverse effect on our international operations or on our business, financial condition and results of operations.

We operate in a very competitive business environment.

     The orthopedic sports medicine market is highly competitive and fragmented. Our competitors include a few large, diversified general orthopedic products companies and numerous smaller niche companies. Some of our competitors are part of corporate groups that have significantly greater financial, marketing and other resources than we do. Accordingly, we may be at a competitive disadvantage with respect to these competitors. Our primary competitors in the rigid knee bracing product line include Bledsoe Brace Systems (a division of Medical Technology, Inc.), Breg, Inc., Generation II USA, Inc., Innovation Sports Incorporated and Townsend Industries Inc. Our competitors in the soft goods products segment include DeRoyal Industries, Tecnol Orthopedics (a division of Encore Medical Corporation) and Zimmer Holdings, Inc. We compete with a variety of manufacturers of specialty and other complementary orthopedic products, depending on the type of product. In addition, in certain foreign countries, we compete with one or more local competitors such as Bauerfeind in Germany and FGP in Italy. As competition in any of these markets becomes stronger, we may not realize profit margins at the same rate as today.

We rely on suppliers in China and other parts of Asia for a portion of our finished soft goods products, which makes us susceptible to supply shortages of these products.

     Some of our important suppliers are in China and other parts of Asia. We obtain approximately 8% of our total purchased materials from suppliers in China and other parts of Asia providing us predominately finished soft goods products. Political and economic instability and changes in government regulations in these areas could affect our ability to continue to receive materials from our suppliers there. The loss of our suppliers in China and other parts of Asia or any other interruption or delay in the supply of our required materials or our inability to obtain these materials at acceptable prices and within a reasonable amount of time could impair our ability to meet scheduled product deliveries to our customers and could hurt our reputation and cause customers to cancel orders. For example, in October 2002, a strike among dock workers along the west coast of the United States caused a significant interruption in supply of products from China and other parts of Asia and led to increased backlog of orders and additional costs.

Our lack of local manufacturing operations outside North America may cause our products to be less competitive in international markets.

     We currently have no manufacturing operations in any foreign country other than Mexico. For our international sales to third party distributors, the cost of transporting our products to foreign countries is currently borne by our third party distributors who are also often required to pay foreign import duties on our products. As a result, the cost of our products to our third party distributors is often greater than products manufactured in that country. In addition, foreign manufacturers of competitive products often receive various local tax concessions which lower their overall manufacturing costs. In order to compete successfully in international markets, we may be required to open or acquire manufacturing operations abroad, which would be costly to implement and would increase our exposure to the risks of doing business in foreign countries. We may not be able to successfully operate offshore manufacturing operations, which could have a material adverse effect on our international operations or on our business, financial condition and results of operations.

We rely on intellectual property to develop and manufacture our products and our business could be adversely affected if we lose our intellectual property rights.

     We hold U.S. and foreign patents relating to a number of our components and products and have patent applications pending with respect to other components and products. We also expect to apply for additional patents as we deem appropriate. We believe that several of our existing patents are, and will continue to be, extremely important to our success. These include the patents relating to our:

	•		“Four Points of Leverage” system, the critical element in the design of all of our ligament braces;
	•		Custom Contour Measuring System, which serves as an integral part of the measurement process for patients ordering our customized ligament and osteoarthritic braces;
	•		series of hinges for our post-operative braces;

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	•		pneumatic pad design and production technologies which utilize air inflatable cushions that allow the patient to vary the location and degree of support provided by braces such as the Defiance® brace;
	•		osteoarthritis bracing concepts;
	•		ankle bracing, both rigid and soft; and
	•		rigid shoulder bracing.

         However, we cannot assure you that:

	•		our existing or future patents, if any, will afford us adequate protection;
	•		our patent applications will result in issued patents; or
	•		our patents will not be circumvented or invalidated.

     The patent for our “Four Points of Leverage” system is registered only in the United States and expires in January 2005. Products using the “Four Points of Leverage” system represented approximately 22%, 26% and 27% of our net revenues, excluding freight revenue, in 2002, 2001 and 2000, respectively. The expiration of this patent could have a material adverse effect on our business, financial condition and results of operations.

     Our osteoarthritis bracing concept patents represented approximately 5% of our net revenues, excluding freight revenue, in each of 2002, 2001 and 2000. These patents are currently involved in a patent infringement lawsuit. See risk factor below titled “Our operating results and financial condition could be adversely affected if we become involved in litigation regarding our patents or other intellectual property rights.” The loss of such patents could have a material adverse effect on our business, financial condition and results of operations.

     Our success also depends on non-patented proprietary know-how, trade secrets, processes and other proprietary information. We employ various methods to protect our proprietary information, including confidentiality agreements and proprietary information agreements with vendors, employees, consultants and others who have access to our proprietary information. However, these methods may not provide us with adequate protection. Our proprietary information may become known to, or be independently developed by, competitors, or our proprietary rights in intellectual property may be challenged, any of which could have a material adverse effect on our business, financial condition and results of operations.

Our operating results and financial condition could be adversely affected if we become involved in litigation regarding our patents or other intellectual property rights.

     The orthopedic products industry has experienced extensive litigation regarding patents and other intellectual property rights. We or our products may become subject to patent infringement claims or litigation or interference proceedings declared by the United States Patent and Trademark Office (USPTO) or the foreign equivalents thereto to determine the priority of inventions. The defense and prosecution of intellectual property suits, USPTO interference proceedings or the foreign equivalents thereto and related legal and administrative proceedings are both costly and time-consuming. An adverse determination in litigation or interference proceedings to which we may become a party could:

	•		subject us to significant liabilities to third parties;
	•		require disputed rights to be licensed from a third party for royalties that may be substantial; or
	•		require us to cease using such technology.

     Any one of these outcomes could have a material adverse effect on us. Furthermore, we may not be able to obtain necessary licenses on satisfactory terms, if at all. Accordingly, adverse determinations in a judicial or administrative proceeding or our failure to obtain necessary licenses could prevent us from manufacturing and selling our products, which would have a material adverse effect on our business, financial condition and results of operations. Moreover, even if we are successful in such litigation, the expense of defending such claims could have a material adverse effect on our business, financial condition and results of operations.

     On June 7, 2002, a patent infringement action was filed against us and our former parent, Smith & Nephew, by Generation II Orthotics Inc. and Generation II USA Inc. The suit alleges that we and Smith & Nephew willfully infringed,

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and are infringing, certain osteoarthritis bracing concept patents by manufacturing, using and selling certain orthopedic knee braces for the treatment of unicompartmental osteoarthritis. The lawsuit seeks unspecified monetary damages and an injunction to prevent us from infringing the patents and from selling the relevant knee braces. We believe the claims are without merit and intend to defend the action vigorously. We have filed an answer and counterclaims seeking to invalidate the patents. Pursuant to a prior contractual obligation, we have agreed to indemnify and defend Smith & Nephew in this matter. The parties conducted a mediation session on this matter on March 25, 2003, and settlement discussions are occurring. No assurance can be given that the action will settle or that we will be able to achieve a favorable outcome in this litigation. See risk factor above titled “We rely on intellectual property to develop and manufacture our products and our business could be adversely affected if we lose our intellectual property rights.”

     In addition, we have from time to time needed to, and may in the future need to, litigate to enforce our patents, to protect our trade secrets or know-how or to determine the enforceability, scope and validity of the proprietary rights of others. Such prosecution of our intellectual property rights could involve counterclaims against us. Any future litigation or interference proceedings will result in substantial expense to us and significant diversion of effort by our technical and management personnel.

We have a single stockholder who can substantially influence the outcome of all matters voted upon by its stockholders and the interests of that stockholder may not be aligned with yours.

     J.P. Morgan DJ Partners, LLC (JPMDJ Partners) beneficially owns approximately 45.6% of our outstanding common stock. As a result, JPMDJ Partners is able to substantially influence all matters requiring the approval of our stockholders, including the election of directors and the approval of significant corporate transactions, such as acquisitions, and to block an unsolicited tender offer and any other matter requiring a supermajority vote of its stockholders. This concentration of ownership could delay, defer or prevent a change in control of dj Orthopedics, Inc. or impede a merger, consolidation, takeover or other business combination which a stockholder may otherwise view favorably.

Because we have various mechanisms in place to discourage takeover attempts, a change in control of our company that a stockholder may consider favorable could be prevented.

     Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a change in control of our company that a stockholder may consider favorable. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors and take other corporate actions. These provisions include:

	•		authorizing the issuance of “blank check” preferred stock that could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt;
	•		a classified board of directors with staggered, three-year terms, which may lengthen the time required to gain control of the board of directors;
	•		prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
	•		requiring supermajority voting to effect particular amendments to our certificate of incorporation and bylaws;
	•		limitations on who may call special meetings of stockholders;
	•		prohibiting stockholder action by written consent, thereby requiring all actions to be taken at a meeting of the stockholders; and
	•		establishing advance notice requirements for the nomination of candidates for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.

     In addition, Section 203 of the Delaware General Corporation Law prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns or within the last three years has owned 15% of our voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. Accordingly, Section 203 may discourage, delay or prevent a change in control of our company.

     As a result, these provisions could limit the price that investors are willing to pay in the future for shares of our common stock.

Risks Related to Government Regulation

Our failure to receive regulatory clearance or approval for our products or operations in the United States or abroad would adversely affect our revenues and potential for future growth.

     Our products and operations are subject to extensive regulation in the United States by the Food and Drug Administration. (See “Governmental Regulation – Medical Device Regulation” above.) The submission for a bone growth stimulation product under development is currently under review by the FDA and has been subject to substantial delay. At this point, we do not have an estimate of when or whether final FDA approval will occur and there can be no assurance that this delay in the approval process will not have a material adverse effect on our ability to sell the product in the United States in the future. Failure to obtain FDA clearance or approvals of the product or other new products we develop in the future, any limitations imposed by the FDA on new product development or use, or the costs of obtaining FDA clearance or approvals could have a material adverse effect on our business, financial condition and results of operations.

     In many of the foreign countries, in which we market our products, we are subject to extensive regulations similar to those of the FDA, including those in Germany, our largest foreign market. (See “Governmental Regulation – Medical Device Regulation – International” above.) Failure to receive, or delays in the receipt of, relevant foreign qualifications could also have a material adverse effect on our business, financial condition, and results of operations. Due to the movement towards harmonization of standards in the European Union, we expect a changing regulatory environment in Europe characterized by a shift from a country-by-country regulatory system to a European Union wide single regulatory system. The timing of this harmonization and its effect on us cannot currently be predicted. Any such developments could have a material adverse effect on our business, financial condition and results of operations.

Changes in reimbursement policies for our products by third party payers or reductions in reimbursement rates for our products could adversely affect our business and results of operations.

     The ability of orthopedic sports medicine surgeons and their allied healthcare professionals (or persons to whom they sell our products) to receive reimbursement for the cost of our products from private third party payers and, to a lesser extent, Medicare, Medicaid and other governmental programs, is important to our business. Limitations or reductions in permitted reimbursement for our products can have a material adverse effect on our sales and profitability.

     Congress and certain state legislatures are considering reforms in the healthcare industry that may modify reimbursement practices, including controls on healthcare spending through limitations on the growth of Medicare and Medicaid spending. It is not clear at this time what proposals, if any, will be adopted or, if adopted, what effect these proposals would have on our business. In addition to extensive existing government healthcare regulation, there are legislative proposals at the federal level such as competitive bidding, which pursuant to the Balanced Budget Act of 1997, was evaluated in

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demonstration projects in Texas and Florida. Under competitive bidding, Medicare would change its approach to reimbursing certain items and services covered by Part B from the current fee schedule amount to an amount that would be established through a bidding process between the government and suppliers. If Congress decides to apply competitive bidding nationally, this may reduce the number of suppliers providing certain items and services to Medicare beneficiaries and the amounts paid for such items and services. Such reductions could have a material adverse effect on our business, financial condition and results of operations.

     Further, on February 11, 2003, the Centers for Medicare and Medicaid Services (CMS) made effective an interim final rule implementing the inherent reasonableness authority, which allows adjustments to payment amounts by up to 15 percent per year for certain items and services covered by Part B when the existing payment amount is determined to be grossly excessive or grossly deficient. The regulation lists factors that may be used to determine whether an existing reimbursement rate is grossly excessive or grossly deficient and to determine what is a realistic and equitable payment amount. Also, under the regulation, a payment amount will not be considered grossly excessive or grossly deficient if an overall payment adjustment of less than fifteen percent would be necessary to produce a realistic and equitable payment amount. Using this authority, CMS may reduce reimbursement levels for certain items and services covered by Part B, which could have a material adverse effect on our business, financial condition and results of operations.

     Many private health insurance plans tailor their coverage and reimbursement policies after Medicare policies. If enacted, Congressional or regulatory measures that reduce Medicare reimbursement rates could cause private health insurance plans to reduce their reimbursement rates for our products, which could have an adverse effect on our ability to sell our products or cause our orthopedic professional customers to use less expensive products introduced by us and our competitors.

     Failure by users of our products to obtain sufficient reimbursement from third party payers for our products or adverse changes in governmental and private payers’ policies toward reimbursement for our products could have a material adverse effect on our business, financial condition and results of operations. We cannot assure you that third party reimbursement for our products will continue to be available or at what rate such products will be reimbursed.

     Similar to our domestic business, our success in international markets also depends upon the eligibility of our products for reimbursement through government sponsored healthcare payment systems and third party payers. Reimbursement practices vary significantly by country, with certain countries, most notably France, requiring products to undergo a lengthy regulatory review in order to be eligible for third party reimbursement. In addition, healthcare cost containment efforts similar to those we face in the United States are prevalent in many of the foreign countries in which our products are sold and these efforts are expected to continue in the future, possibly resulting in the adoption of more stringent standards. For example, in Germany, our largest foreign market, reimbursement by government sponsored healthcare payment systems for some categories of our products was decreased in 1997. Under the current formula, the German government reimburses 80% of the cost of the affected products and patients bear the remaining 20% of the cost. In Italy, our rigid knee bracing products and cold therapy systems, among others, are no longer eligible for reimbursement. In the United Kingdom, while reimbursement for our products through the National Health Service (NHS), is currently available, the cost of our products is not reimbursed by private health insurance plans and orthopedic professionals are being pressured by the NHS to reduce or eliminate the number of rigid knee braces prescribed for orthopedic patients. Any developments in our foreign markets that eliminate or reduce reimbursement rates for our products could have an adverse effect on our ability to sell our products or cause our orthopedic professional customers to use less expensive products, which could have a material adverse effect on our results of operations.

Healthcare reform, managed care and buying groups have put downward pressure on the prices of our products.

     Within the United States, healthcare reform and managed care are changing the dynamics of the healthcare industry in response to the need to control rising healthcare costs. As a result of healthcare reform, the U.S. healthcare industry has seen a rapid expansion of managed care organizations. The development of managed care programs in which the providers contract to provide comprehensive healthcare to a patient population at a fixed cost per person (referred to as capitation) has put pressure on, and is expected to continue to lead, healthcare providers to lower costs. The advent of managed care has also resulted in greater attention to the tradeoff between patient need and product cost, so-called demand matching, where patients are evaluated as to age, need for mobility and other parameters and are then matched with an orthopedic product that is cost effective in light of such evaluation. One result of demand matching has been, and is expected to continue to be, a shift toward lower priced products, and any such shift in our product mix to lower margin, off-the-shelf products could have an adverse impact on our operating results. For example, in our rigid knee-bracing segment, we and many of our competitors are offering lower priced, off-the-shelf products in response to managed care customers.

     A further result of managed care and the related pressure on costs has been the advent of buying groups in the United States. Such buying groups enter into preferred supplier arrangements with one or more manufacturers of orthopedic

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or other medical products in return for price discounts. The extent to which such buying groups are able to obtain compliance by their members with such preferred supplier agreements varies considerably depending on the particular buying groups. In response to the organization of new buying groups, we have entered into national contracts with selected groups and believe that the high levels of product sales to such groups and the opportunity for increased market share have the potential to offset the financial impact of discounting. We believe that our ability to maintain our existing arrangements will be important to our future success and the growth of our revenues. In addition, we may not be able to obtain new preferred supplier commitments for major buying groups, in which case we could lose significant potential sales, to the extent these groups are able to command a high level of compliance by their members. On the other hand, if we receive preferred supplier commitments from particular groups which do not deliver high levels of compliance, we may not be able to offset the negative impact of lower per unit prices or lower margins with any increases in unit sales or in market share, which could have a material adverse effect on our business, financial condition and results of operations.

     In international markets, where the movement toward healthcare reform and the development of managed care are generally not as advanced as in the United States, we have experienced downward pressure on product pricing and other effects of healthcare reform similar to that which we have experienced in the United States. We expect healthcare reform and managed care to continue to develop in our primary international markets, which we expect will result in further downward pressure in product pricing. The timing and the effects on us of healthcare reform and the development of managed care in international markets cannot currently be predicted.

Proposed laws that would limit the types of orthopedic professionals who can fit, sell or seek reimbursement for our products could, if adopted, adversely affect our business and results of operations.

     Congress and state legislatures have from time to time, in response to pressure from certain orthopedic practitioners, considered proposals which limit the types of orthopedic professionals who can fit and/or sell our products or who can seek reimbursement for our products. Several states have adopted legislation which imposes certification or licensing requirements on the measuring, fitting and adjusting of certain orthotic devices. Some of these laws, have exemptions, which exempt manufacturers’ representatives. Others apply to the activities of these representatives. Other states may be considering such legislation. Such laws could limit our potential customers in those jurisdictions in which such legislation or regulations are enacted by limiting the measuring and fitting of these devices to certain licensed individuals. We may not be successful in opposing their adoption, and, therefore, such laws could have a material adverse effect on our business, financial condition and results of operations.

We may need to change our business practices to comply with healthcare fraud and abuse regulations.

     We are subject to various federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, imprisonment and exclusion from participation in federal and state healthcare programs, including Medicare, Medicaid, Veterans Administration health programs and TRICARE. We have not been challenged by a governmental authority under any of these laws and believe that our operations are in material compliance with such laws. However, because of the far-reaching nature of these laws, we may be required to alter one or more of our practices to be in compliance with these laws. Healthcare fraud and abuse regulations are complex and even minor, inadvertent irregularities in submissions can potentially give rise to claims that a fraud and abuse law or regulation has been violated. Any violations of these laws or regulations could result in a material adverse effect on our business, financial condition and results of operations. If there is a change in law, regulation or administrative or judicial interpretations, we may have to change our business practices or our existing business practices could be challenged as unlawful, which could have a material adverse effect on our business, financial condition and results of operations.

Denied claims from government agencies could reduce our revenue or profits.

     Medicare contractors and Medicaid agencies periodically conduct pre- and post-payment review and other audits of claims, and are under increasing pressure to scrutinize more closely healthcare claims. We cannot assure you that such reviews and/or similar audits of our claims will not result in material recoupments or denials, which could have a material adverse effect on our business, results of operations or financial condition.

Risks Related to our Debt Level

Our substantial indebtedness could limit our ability to operate our business, obtain additional financing and pursue other business opportunities.

     We are highly leveraged, which means we have a large amount of indebtedness in relation to our stockholders’

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equity. We may incur additional indebtedness from time to time to finance acquisitions, investments or strategic alliances or capital expenditures or for other purposes.

     Our high degree of leverage could have negative consequences for us, including the following:

	•		our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired or such financing may not be available on favorable terms;
	•		we will need a substantial portion of our cash flow to pay the principal and interest on our indebtedness, including indebtedness that we may incur in the future;
	•		payments on our indebtedness will reduce the funds that would otherwise be available for our operations and future business opportunities;
	•		a substantial decrease in our net operating cash flows could make it difficult for us to meet our debt service requirements and force us to modify our operations;
	•		we may be more highly leveraged than our competitors, which may place us at a competitive disadvantage;
	•		our debt level may make us more vulnerable than our competitors to a downturn in our business or the economy generally;
	•		our debt level reduces our flexibility in responding to changing business and economic conditions;
	•		some of our debt has a variable rate of interest, which exposes us to the risk of increased interest rates; and
	•		there would be a material adverse effect on our business and financial condition if we are unable to service our indebtedness or obtain additional financing, as needed.

Our debt agreements contain operating and financial restrictions which may restrict our business and financing activities.

     The operating and financial restrictions and covenants in our bank credit facility, the indenture governing our outstanding Senior Subordinated Notes and any future financing agreements may adversely affect our ability to finance future operations, meet our capital needs or engage in our business activities. Currently, our existing debt agreements restrict our ability to:

	•		incur additional indebtedness;
	•		issue redeemable equity interests and preferred equity interests;
	•		pay dividends or make distributions, repurchase equity interests or make other restricted payments;
	•		redeem indebtedness that is subordinated in right of payment to the Notes;
	•		make capital expenditures;
	•		create liens;
	•		enter into certain transactions with affiliates;
	•		make investments;
	•		sell assets; or
	•		enter into mergers or consolidations.

     With respect to mergers or acquisitions, our bank credit facility and the indenture governing the Notes limit our ability to finance acquisitions through additional borrowings. In addition, our bank credit facility prohibits us from acquiring assets or the equity of another company without the consent of the lenders if:

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	•		we acquire less than 100% of the equity of the acquired company, in the case of an acquisition of equity;
	•		the assets or entity acquired are in a different line of business from ours;
	•		after giving effect to the acquisition, a pro forma consolidated leverage ratio and pro forma interest coverage ratio are not satisfied; and
	•		the purchase price exceeds $30 million in the case of any one acquisition or $50 million in the aggregate of which no more than $10 million may involve acquisitions outside the United States.

     The bank credit facility also limits investments in joint ventures to an aggregate limit of $3,000,000, and limits other investments to $1,000,000.

     Restrictions contained in the indenture and the bank credit facility could:

	•		limit our ability to plan for or react to market conditions or meet capital needs or otherwise restrict our activities or business plans; and
	•		adversely affect our ability to finance our operations, acquisitions, investments or strategic alliances or other capital needs or to engage in other business activities that would be in our interest.

     A breach of any of these covenants, ratios, tests or other restrictions could result in an event of default under the bank credit facility and/or the indenture. Upon the occurrence of an event of default under the bank credit facility, the lenders could elect to declare all amounts outstanding under the bank credit facility, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lenders could proceed against the collateral granted to them to secure such indebtedness. If the lenders under the bank credit facility accelerate the payment of the indebtedness, there can be no assurance that our assets would be sufficient to repay in full such indebtedness and our other indebtedness, including the Notes referred to below. We may not have sufficient cash to service our indebtedness. Our ability to pay principal and interest on the Notes and to satisfy our other obligations will depend upon, among other things:

	•		our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, many of which are beyond our control; and
	•		the future availability of borrowings under our revolving bank credit facility or any successor facility, the availability of which depends or may depend on, among other things, our complying with covenants in our bank credit facility.

     If we cannot service our indebtedness, we will be forced to take actions such as reducing or delaying acquisitions, investments, strategic alliances and/or capital expenditures, selling assets, restructuring or refinancing our indebtedness, or seeking additional equity capital or bankruptcy protection. We can not assure you that any of these remedies can be effected on satisfactory terms, if at all. In addition, the terms of existing or future debt agreements, including the bank credit facility and the indenture, may restrict us from adopting any of these alternatives.

Special Risks For Our Note Holders

     Holders of our 12 5/8% Senior Subordinated Notes due 2009 (the Notes) of which an aggregate face amount of $75 million are outstanding, are subject to additional market and repayment risks arising from the terms of the Notes and our debt level and corporate structure, some of which are described below. The Notes were issued in 1999 by dj Orthopedics, LLC, our principal operating company, and were co-issued by DJ Capital Corporation, a company formed solely to act as co-issuer of the Notes. Payment of the Notes is guaranteed by dj Orthopedics, Inc, our publicly held entity, and dj Development Corporation, a company formed solely to hold our intellectual property assets. None of our foreign subsidiaries has guaranteed payment of the Notes. In the discussion of risks to holders of the Notes set forth below, the terms we, us and our refer to dj Orthopedics, LLC and DJ Orthopedics Capital Corporation, the co-issuers of the Notes. dj Orthopedics, Inc. is referred to as “dj Orthopedics”, and dj Development Corporation is referred to as “dj Development”. The term “indenture” as used below refers to the indenture we entered into that contains the agreements between us and the holders of the Notes.

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The Notes and the guarantees by dj Orthopedics and dj Development are, and guarantees by any of our future subsidiaries will be, effectively subordinated to all senior debt of our subsidiaries.

     The Notes are subordinated in right of payment to the prior payment in full of all our existing and future senior indebtedness and the guarantee of the Notes by dj Orthopedics, dj Development and any future subsidiaries providing a guarantee of the Notes will be subordinated in right of payment to all senior indebtedness of the applicable guarantor. The indenture requires each of our domestic subsidiaries that is formed or acquired in the future to guarantee the Notes, unless we designate the subsidiary as an Unrestricted Subsidiary (as defined in the indenture). As of December 31, 2002, we had approximately $35.8 million of senior indebtedness outstanding (excluding $25.0 million available and unused under a revolving bank credit facility), all of which is secured. In addition, the indenture permits us and our Restricted Subsidiaries (as defined in the indenture) to incur additional senior indebtedness, including indebtedness under the bank credit facility. We or the applicable guarantor may not pay principal, premium (if any), interest or other amounts on account of the Notes or the guarantees by dj Orthopedics and dj Development or any subsidiary in the event of a payment default on, or another default that has resulted in the acceleration of, certain senior indebtedness (including debt under the bank credit facility) unless such indebtedness has been paid in full or the default has been cured or waived. In the event of certain other defaults with respect to certain senior indebtedness, we or the applicable guarantor may not be permitted to pay any amount on account of the Notes or the guarantees by dj Orthopedics and dj Development or any subsidiary for a designated period of time. In the event of a bankruptcy, liquidation, dissolution, reorganization or similar proceeding with respect to us or a guarantor, our assets or a guarantor’s assets, as the case may be, will be available to pay obligations on the Notes or the guarantor’s guarantee, as applicable, only after our senior indebtedness or the senior indebtedness of that guarantor has been paid in full, and there can be no assurance that there will be sufficient assets remaining to pay amounts due on all or any of the Notes or any guarantee of the Notes.

     Our right to receive assets of any subsidiary which is not a guarantor upon the liquidation or reorganization of that subsidiary (and thus the rights of the holders of Notes to realize any value with respect to those assets) will be subject to the prior claims of creditors of that subsidiary (including trade creditors). Accordingly, since our foreign subsidiaries are not guarantors of the Notes, the Notes are effectively subordinated to all liabilities (including trade payables and contingent liabilities) of our foreign subsidiaries and any of our future subsidiaries that do not provide a guarantee of the Notes except to the extent that we are recognized as a creditor of such subsidiary. However, even if we were recognized as a creditor of a subsidiary that does not guarantee the Notes, our claims would still be subordinate to any security interest in the assets of that subsidiary, and any indebtedness of that subsidiary senior to that held by us. As of December 31, 2002, the aggregate amount of the liabilities of our foreign subsidiaries as reflected on our balance sheet was $0.8 million.

Indebtedness under our bank credit facility is secured while our obligations under the Notes are not secured and if we default under our senior debt, our senior lenders can foreclose on the assets we have pledged to secure payment of the senior debt to your exclusion.

     In addition to being contractually subordinated to all existing and future senior indebtedness, our obligations under the Notes (and dj Orthopedics’ and dj Development’s obligations under their guarantees) are unsecured while our obligations under the bank credit facility (and dj Orthopedics’ and dj Development’s obligations under their guarantee of our indebtedness under the bank credit facility) are secured by a security interest in substantially all of our assets and the assets of dj Orthopedics (which consist principally of 100% of our equity interests) and each of our existing and subsequently acquired or organized U.S. and, subject to certain limitations, non-U.S. subsidiaries, including a pledge of all of the issued and outstanding equity interests in our existing or subsequently acquired or organized U.S. subsidiaries and 65% of the equity interests in each of our subsequently acquired or organized non-U.S. subsidiaries. If we are declared bankrupt or insolvent or if we default under the bank credit facility, the lenders could declare all of the funds borrowed under the bank credit facility, together with accrued interest, immediately due and payable. If we were unable to repay that indebtedness, the lenders could foreclose on our equity interests pledged by dj Orthopedics, on the pledged equity interests of our subsidiaries and on the assets in which they have been granted a security interest, in each case to your exclusion, even if an event of default exists under the indenture at such time. Furthermore, if all equity interests of any future subsidiary guarantor are sold to persons pursuant to an enforcement of the pledge of equity interests in that subsidiary guarantor for the benefit of the senior lenders, then the applicable subsidiary guarantor will be released from its guarantee of the Notes automatically and immediately upon such sale.

Our bank credit facility requires us to make mandatory payments, which could limit our ability to grow our business.

     We are required to make annual mandatory payments of the term loans under the bank credit facility in an amount equal to 50% of our excess cash flow (75% if our ratio of total debt to EBITDA exceeds 4 to 1). Excess cash flow represents our net income adjusted for extraordinary gains or losses, depreciation, amortization and other non-cash charges, changes in working capital, changes in deferred revenues, payments for capital expenditures, and repayment of indebtedness. We had no excess cash flow in 2002, 2001 or 2000.

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In addition, the term loans are subject to mandatory prepayments in an amount equal to:

	•		100% of the net cash proceeds of equity and debt issuance by us, dj Orthopedics or any of our other subsidiaries; and
	•		100% of the net cash proceeds of asset sales or other dispositions of property by us, dj Orthopedics or any of our other subsidiaries,

in each case subject to certain exceptions. A mandatory prepayment of less than $1.0 million was required for the sale of our interest in our Australian subsidiary on December 31, 2002. On March 28, 2003, we made a total prepayment of principal on the term loans totaling approximately $20.0 million including the required prepayment. No mandatory prepayments were required for 2001 or 2000. If we have to use cash to make mandatory payments in the future, we may not have sufficient funds to grow our business, to make acquisitions, enter into joint ventures or make capital expenditures.

We may not have the ability to raise the funds necessary to finance the change of control offer required by the indenture.

     Upon a change of control, we are required to offer to purchase all of the Notes then outstanding at 101% of the principal amount thereof plus accrued interest. If a change of control were to occur, we may not have sufficient funds to pay the purchase price for the outstanding Notes tendered, and we expect that we would require third party financing. However, we may not be able to obtain such financing on favorable terms, if at all. In addition, the bank credit facility restricts our ability to repurchase the Notes, including pursuant to an offer in connection with a change of control. A change of control under the indenture may also result in an event of default under the bank credit facility and may cause the acceleration of other senior indebtedness, if any, in which case the subordination provisions of the Notes would require payment in full of the bank credit facility and any other senior indebtedness before repurchase of the Notes. Our future indebtedness may also contain restrictions on our ability to repay the Notes upon certain events or transactions that could constitute a change of control under the indenture. The inability to repay senior indebtedness upon a change of control or to purchase all of the tendered Notes would each constitute an event of default under the indenture.

     The change of control provision in the indenture will not necessarily afford you protection in the event of a highly leveraged transaction, including reorganization, restructuring, merger or other similar transaction involving us that may adversely affect you. Such a transaction may not involve a change in voting power or beneficial ownership, or, even if it does, may not involve a change of the magnitude required under the definition of change of control in the indenture to trigger this provision

Federal and state laws permit a court to void the Notes and guarantees under certain circumstances.

     Our obligations under the indenture and the Notes, the obligations incurred by DonJoy L.L.C., under the indenture and its guarantee of the Notes and assumed by dj Orthopedics in the reorganization and the obligations incurred by dj Development under the indenture and its guarantee of the Notes may be subject to review under federal bankruptcy law or relevant state fraudulent conveyance and similar statutes in a bankruptcy or reorganization case or lawsuit commenced by or on behalf of our or dj Orthopedics’ or dj Development’s unpaid creditors. Under these laws, if a court were to find that, at the time we issued the Notes, DonJoy issued its guarantee of the Notes or dj Development issued its guarantee of the Notes, we DonJoy, or dj Development, as the case may be:

	•		incurred such indebtedness with the intent of hindering, delaying or defrauding present or future creditors; or
	•		received less than the reasonably equivalent value or fair consideration for incurring such indebtedness; and
	•		were insolvent or rendered insolvent by reason of any of the recapitalization transactions;
	•		were engaged or about to engage in a business or transaction for which our or the applicable guarantors’ assets constituted unreasonably small capital to carry on our or its business; or
	•		intended to incur, or did incur, or believed that we or the applicable guarantor would incur, debts beyond our or the applicable guarantor’s ability to pay as they matured or became due;

then, such court might:

•

subordinate the Notes or dj Orthopedics’ and dj Development’s guarantee of the Notes to our or dj

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			Orthopedics’ and dj Development’s presently existing or future indebtedness;
	•		void the issuance of the Notes (in our case) or the guarantees or;
	•		take other actions detrimental to holders of the Notes.

     The measure of insolvency for purposes of the foregoing will vary depending upon the law of the jurisdiction being applied. Generally, an entity will be insolvent if:

	•		the fair salable value of its assets were less than the amount required to pay its total existing debts and liabilities (including contingent liabilities) as they become absolute or mature; or
	•		the sum of its debts (including contingent liabilities) were greater than its assets, at fair valuation.

     We cannot predict:

	•		what standard a court would apply in order to determine whether we or the applicable guarantor were insolvent as of the date we or the applicable guarantor issued the old Notes or the guarantee, or that regardless of the method of valuation a court would determine that we or the applicable guarantor were insolvent on that date; or
	•		whether a court would not determine that the payments constituted fraudulent transfers on another ground.

     In rendering their opinions in connection with the issuance of the Notes, our counsel and counsel to the initial purchaser of the Notes did not express any opinion as to the applicability of federal bankruptcy or state fraudulent transfer and conveyance laws.

     To the extent a court voids a guarantee as a fraudulent conveyance or holds it unenforceable for any other reason, holders of the Notes would cease to have any claim in respect of the guarantor and would be creditors solely of us.

     Based upon financial and other information available to us, we believe that we issued the Notes and the guarantors issued the guarantees for proper purposes and in good faith and that at the time we and the guarantors were not insolvent or rendered insolvent thereby, had sufficient capital to run our businesses, and were able to pay our debts as they mature or become due. In reaching these conclusions, we relied on various valuations and estimates of future cash flow that necessarily involve a number of assumptions and choices of methodology. However, a court may not adopt the assumptions and methodologies we have chosen or concur with our conclusion as to our solvency.

     Additionally, under federal bankruptcy or applicable state insolvency law, if certain bankruptcy or insolvency proceedings were initiated by or against us or dj Orthopedics or dj Development within 90 days after any payment by us with respect to the Notes or by dj Orthopedics and dj Development under their guarantees of the Notes, or if we or dj Orthopedics or dj Development anticipated becoming insolvent at the time of such payment, all or a portion of such payment could be avoided as a preferential transfer and the recipient of such payment could be required to return such payment.

     In the event there are any subsidiary guarantors in the future, the foregoing would apply to their guarantees.

There is no active trading market for the Notes.

     The Notes are not listed on a securities exchange or any automated dealer quotation system. J.P. Morgan Securities, Inc. (JPMSI) makes a market in the Notes. JPMSI is not obligated to do so, however, and any market-making activities with respect to the Notes may be discontinued at any time without notice. In addition, this market-making activity is subject to limits imposed by federal securities laws. Because JPMSI is our affiliate, JPMSI is required to deliver a current market-making prospectus and otherwise comply with the registration requirements of the Securities Act of 1933 in any secondary market sale of the Notes. Accordingly, the ability of JPMSI to continue to make a market in the Notes depends, in part, on our ability to maintain a current market-making prospectus.

     The liquidity of the trading market in the Notes, and the market price quoted for the Notes may be adversely affected by changes in the overall market for high yield securities and by changes in our financial performance or prospects or in the prospects for companies in our industry generally. As a result, you cannot be sure that an active trading market will develop for the Notes.

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Item 2. Properties

     We are headquartered in Vista, California and operate manufacturing locations in Vista and in Tijuana, Mexico. The manufacturing facilities located in Tijuana, Mexico, are conducted in three buildings in a campus environment and are within 100 miles of Vista. We also lease warehouse and office space in Germany, Canada and the United Kingdom. As part of our restructuring, we intend to sublease a portion of our Vista facility in the future.

Item 3. Legal Proceedings

     Several class action complaints were filed in the United States District Courts for the Southern District of New York and for the Southern District of California on behalf of purchasers of our common stock alleging violations of the federal securities laws in connection with our November 15, 2001 initial public offering. dj Orthopedics, Inc. is named as a defendant along with Leslie H. Cross, our President and Chief Executive Officer, Cyril Talbot III, our former Senior Vice President, Finance, Chief Financial Officer, and Secretary, Charles T. Orsatti, former Chairman of our Board of Directors, and the underwriters of our initial public offering. The complaints sought unspecified damages and alleged that defendants violated Sections 11, 12, and 15 of the Securities Act of 1933 by, among other things, misrepresenting and/or failing to disclose material facts in connection with our registration statement and prospectus for the initial public offering. On February 25, 2002, plaintiffs agreed to dismiss the New York actions without prejudice. On February 28, 2002, a federal district court judge consolidated the Southern District of California actions into a single action, In re DJ Orthopedics, Inc. Securities Litigation, Case No. 01-CV-2238-K (LSP) (S.D. Cal.), and appointed Oracle Partners, L.P. as lead plaintiff. On May 3, 2002, the lead plaintiff filed its consolidated amended complaint, which alleges the same causes of action and adds our outside directors Mitchell J. Blutt, M.D., Kirby L. Cramer, and Damion E. Wicker, M.D. as defendants. On June 17, 2002, we and the other defendants filed a motion to dismiss the consolidated complaint. On August 6, 2002, the Court granted in part and denied in part the motion to dismiss. The Court dismissed several categories of the misstatements and omissions alleged by plaintiffs. The remaining allegation pertains to a purported failure to disclose material intra-quarterly sales data in the registration statement and prospectus. We believe the claims are without merit and intend to defend the action vigorously. However, there can be no assurance that we will succeed in defending or settling this action. Additionally, we cannot assure you that the action will not have a material adverse effect on our business, financial condition and results of operations.

     On June 7, 2002, a patent infringement action was filed against us and our former parent, Smith & Nephew, in the United States District Court, Eastern District of Texas, Case No. 2:02CV-123-TJW by Generation II Orthotics Inc. and Generation II USA Inc. The suit alleges that we and Smith & Nephew willfully infringed, and are infringing, U.S. Patent

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No. 5,302,169 and U.S. Patent No. 5,400,806 by manufacturing, using and selling certain orthopedic knee braces for the treatment of unicompartmental osteoarthritis. The lawsuit seeks unspecified monetary damages and an injunction to prevent us from infringing the patents and from selling the relevant knee braces. We believe the claims are without merit and intend to defend the action vigorously. We have filed an answer and counterclaims seeking to invalidate the patents. Pursuant to a prior contractual obligation, we have agreed to indemnify and defend Smith & Nephew in this matter. The parties conducted a mediation session on this matter on March 25, 2003, and settlement discussions are occurring. No assurance can be given that the action will settle or that we will be able to achieve a favorable outcome in this litigation.

     We are from time to time involved in lawsuits arising in the ordinary course of business. With respect to these matters, management believes that it has adequate legal defense, insurance and/or have provided adequate accruals for related costs. We are not aware of any pending lawsuits not mentioned above that could have a material adverse effect on our business, financial condition and results of operations.

Item 4. Submission of Matters to a Vote of Security Holders

     No matters were submitted to a vote of security holders during the quarter ended December 31, 2002.

Item 4A. Executive Officers

     The following table sets forth the name, ages and positions of the Company’s executive officers:

     Leslie H. Cross has been the Chief Executive Officer and President and a director of dj Orthopedics, Inc. since its incorporation in August 2001. He served as the Chief Executive Officer and a Manager of DonJoy, L.L.C., the predecessor of the Company, from June 1999 until November 2001, and has served as President of dj Orthopedics, LLC, the Company’s wholly-owned operating subsidiary, or its predecessor, the Bracing & Support Systems division of Smith & Nephew, Inc. (the “BASS Division”) since June 1995. From 1990 to 1994, Mr. Cross held the position of Senior Vice President of Marketing and Business Development of the BASS Division. He was a Managing Director of two different divisions of Smith & Nephew, Inc. from 1982 to 1990. Prior to that time, he worked at American Hospital Supply Corporation. Mr. Cross earned a diploma in Medical Technology from Sydney Technical College in Sydney, Australia and studied Business at the University of Cape Town in Cape Town, South Africa.

     Vickie L. Capps joined dj Orthopedics, Inc. in July 2002 and serves as Senior Vice President- Finance and Chief Financial Officer. From September 2001 until July 2002, Ms. Capps was employed by AirFiber, a privately held provider of broadband wireless solutions, where she served as Senior Vice President, Finance and Administration and Chief Financial Officer. From July 1999 to July 2001, Ms. Capps served as Vice President of Finance and Administration and CFO for Maxwell Technologies, Inc., a publicly traded technology company. From 1992 to 1999, Ms. Capps served in various positions, including CFO, with Wavetek Wandel Goltermann, Inc., a multinational communications equipment company. Ms. Capps also served as a senior audit and accounting professional for Ernst & Young LLP from 1982 to 1992. Ms. Capps is a California Certified Public Accountant and also serves on the board of directors for Targeted Molecules Corporation of San Diego. Ms. Capps received a Bachelor of Science degree in Business Administration/Accounting from San Diego State University.

     Michael R. McBrayer became Senior Vice President¥Professional Relations and Business Development of dj Orthopedics, LLC in 2001. He has held several other managerial positions with dj Orthopedics, LLC, including Senior Vice President¥Sales, since joining dj Orthopedics, LLC or its predecessor in 1987 as a national sales manager for the retail product line. Mr. McBrayer received his B.S. (Marketing and Management) at Northern Arizona University in Flagstaff, Arizona.

     Donald M. Roberts joined dj Orthopedics in December 2002 and currently serves as Vice President, General Counsel and Secretary. From 1994 to December 2002, Mr. Roberts served as Vice President, Secretary and General Counsel for Maxwell Technologies, Inc., a publicly held technology company. Previous to that, he was with the Los Angeles-based law firm of Parker, Milliken, Clark, O’Hara & Samuelian for 21 years. Mr. Roberts was a shareholder in the firm, having served as partner in a predecessor partnership. Mr. Roberts received his undergraduate degree in Political Science from Yale University and earned his J.D. at the University of California, Berkeley, Boalt Hall School of Law.

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     Luke T. Faulstick has served as Vice President of Operations since July of 2002. He joined dj Orthopedics as Vice President of Manufacturing in June of 2001. From 1998 to July 2002, Mr. Faulstick served as General Manager for Tyco Healthcare. From 1996 to 1998, Mr. Faulstick served as Plant Manager for Mitsubishi Consumer Electronics. In 1994, he started a contract manufacturing business-supplying products to the medical, electronic and photographic industries. Mr. Faulstick began his career in 1985 working for Eastman Kodak Company in Rochester New York where he held various positions in Engineering, Marketing, and Product Research and Development. Mr. Faulstick earned an MS in Engineering from Rochester Institute of Technology and BS in Engineering from Michigan State University.

PART II

Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

     Our common stock has been traded on the New York Stock Exchange since November 15, 2001 under the symbol “DJO”. The following table sets forth for the periods indicated the high and low closing sales prices of the common stock. Prior to November 15, 2001, there was no established public trading market for the common stock.

     As of February 28, 2003, there were 18 holders of record of our common stock. We have never declared or paid any cash dividends on our capital stock. We are effectively prohibited from paying cash dividends on our common stock for the foreseeable future under the terms of our credit agreement. Moreover, we plan to retain all earnings for investment in our business and do not plan to pay cash dividends at any time in the foreseeable future.

Item 6. Selected Financial Data

     The selected financial data set forth below with respect to our consolidated financial statements has been derived from our audited financial statements. The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and Notes thereto appearing elsewhere herein.

     Effective December 31, 2002, we have reclassified certain amounts within our consolidated statements of operations, including expenses related to the shipping and handling of our products to customers ($7.7 million, $7.9 million and $7.2 million in 2002, 2001 and 2000, respectively), which have been reclassified from sales and marketing expense to costs of goods sold. In addition certain common facilities and information technology expenses have been reclassified from general and administrative expenses, partly to costs of goods sold ($2.0 million, $2.0 million and $1.1 million in 2002, 2001 and 2000, respectively) and partly to sales and marketing expense ($0.6 million, $0.7 million and $0.4 million in 2002, 2001 and 2000, respectively) and research and development expense ($0.1 million in 2002, 2001 and 2000). We have also made certain other less material reclassifications. All statement of operations information included herein for the year ended December 31, 2002 has been presented in accordance with the new classifications and all historical information has been reclassified for a consistent presentation.

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		contractual allowances and bad debts related to our OfficeCare® and Insurance programs (see Note 3 of the Notes to our consolidated financial statements).
(c)		The year ended December 31, 2002 includes $3.7 million in charges related to impairment of certain of our long-lived assets (see Note 3 of the Notes to our consolidated financial statements).
(d)		For the year ended December 31, 2002, we recorded $10.0 million in charges related to our performance improvement program (see Note 3 of the Notes to our consolidated financial statements). We recorded merger and integration costs in 2000 associated with the consolidation of the Orthotech operations into our existing facilities including merger and integration and information systems consulting. We recorded restructuring costs in 1998 relating to the consolidation of our operations at our Vista, California facility.
(e)		In 2002, we adopted SFAS No. 145, which required us to reclassify the loss on early extinguishment of debt recorded in 2001 to interest expense and other, net. The charge of approximately $4.7 million for the write-off of unamortized deferred debt issuance costs, debt discount and a prepayment premium was incurred as a result of the redemption of a portion of our Senior Subordinated Notes. The $1.9 million tax benefit related to this charge has been included as a portion of the income benefit for 2001. Discontinued acquisition costs of $0.2 million and $0.4 million for the years ended December 31, 2002 and 2000, respectively, are also included as a portion of interest expense and other, net.
(f)		Because DonJoy, L.L.C. operated as a limited liability company from the date of its recapitalization in June 1999 through November 20, 2001, the date the reorganization was consummated, in accordance with federal, state and local income tax regulations which provide that no income taxes are levied on U.S. limited liability companies and each member of DonJoy, L.L.C. was individually responsible for reporting the member’s share of our net income or loss, we have not provided for income taxes in our historical consolidated financial statements. We have recorded a tax benefit (provision) at an effective tax rate of 40% on our income before income taxes for the period from November 20, 2001, the date of our reorganization, to December 31, 2001 and at an effective tax rate of 38% on our loss before income taxes for the year ended December 31, 2002.
(g)		“EBITDA” is defined as net income (loss) plus interest expense (net of interest income), income taxes, depreciation and amortization. EBITDA is not a measure of performance under generally accepted accounting principles. EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with generally accepted accounting principles, or as a measure of profitability or liquidity. Management has included EBITDA because it may be used by our lenders or certain other investors to analyze and compare companies on the basis of operating performance, leverage and liquidity and to determine a company’s ability to service debt. Under both the bank credit facility definition of EBITDA and our definition of EBITDA, we were in compliance with all debt covenants under the bank credit facility at December 31, 2002. Our definition of EBITDA may not be comparable to that of other companies.
(h)		“Adjusted EBITDA” represents EBITDA, as defined above, adjusted to eliminate amounts permitted under the bank credit facility and those direct charges from Smith & Nephew as well as those allocations of Smith & Nephew’s overhead and other expenses that we have not incurred on a stand-alone basis. These amounts were charged or allocated to us on the basis of direct usage where identifiable, with the remainder allocated to us on the basis of its annual sales or the capital employed by Smith & Nephew in our business. These charges and allocations eliminated include:

	(1)		charges for brand royalties that we paid to Smith & Nephew for use of the Smith & Nephew trademarks and trade names which amounts are no longer paid following the recapitalization since we no longer have the right to use Smith & Nephew trademarks and trade names; foreign sales corporation commissions that we paid on sales to foreign sales corporations established by Smith & Nephew for tax planning purposes which amounts are no longer paid following the recapitalization; Smith & Nephew overhead allocations for corporate managed accounts and new business expense and corporate management expense which were not incurred following consummation of the recapitalization; Smith & Nephew overhead allocations for research and development and for amounts charged by Smith & Nephew for services provided to us for finance (risk management, treasury, audit and taxes), human resources and payroll and legal services; and the incremental adjustment to the carrying value of acquired inventories associated with the Orthotech acquisition to state them at fair value. EBITDA has also been adjusted to reflect the estimated costs we would have incurred to replace the services previously provided by Smith & Nephew. On a stand-alone basis, we have replaced these services provided by Smith & Nephew following the recapitalization and we have incurred additional expenses associated with external auditing and periodic filings with the SEC.
	(2)		other adjustments in accordance with our bank credit facility, including the add back of restructuring charges and certain non-cash charges aggregating $25.1 million in 2002, presented net of discontinued acquisition costs, and restructuring costs in 1998.

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     The calculation of EBITDA is as follows: